For two decades I’ve been managing my own money. It all started when I saved up $3,000 from random minimum wage jobs to open up an online trading account under my father’s guidance. This was in the early 90’s when Charles Schwab first came out. One time I bought a company which I thought sold software, but was actually a bank! Clearly, I had no idea what I was doing. Thankfully, when you start off with only $3,000, the most you can lose is $3,000.
When it takes you several summers at $4 an hour to squirrel away $3,000 only to see half of it vanish in a matter of months due to poor investment decisions, you kind of curse the world. But, you also learn from your mistakes so you can minimize the experience of feeling that dull knife slicing through your financial security. Losing money early on taught me the importance of managing money.
Although the financial crisis of 2008-2009 certainly gave my net worth a massive uppercut to the chin, I didn’t panic. I just started this site and have more than doubled my net worth since then as everything has more than recovered as well. I credit net worth diversification to surviving the crisis and not jumping off a bridge when the S&P 500 hit 666. I also credit my childhood stupidity.
In this article, I want to provide the best advice on how to manage your own money. We will talk about fundamental principles as well as mental states you should accept if you want to continue growing your wealth over the long term.
THE RIGHT MONEY MENTALITY
* You are not a genius. If you think you know everything, you have no idea. By definition, most people are average. I was overly confident about my investing and money management skills in 2007. After all, I worked in finance, graduated magna cum laude, got an MBA in finance, saved over 50% my after tax income, and accumulated a large nut before 30 years old. Who cares? I still lost around ~30% of my net worth in 2008 because I had too much in stocks and real estate. If I was smart, I would have sold all my property by 2007, shorted equities, and loaded up on gold and bonds. But I didn’t, because I was greedy and couldn’t recognize that trees don’t grow to the heavens forever.
* Bad things will always happen. Whenever you have a particular win in your finances, such as scoring a cheap rental property with a 8% rental yield, or reaching a savings milestone of $100,000, expect something bad to happen soon after. Your first tenant might end up being a deadbeat who doesn’t pay on time. You end up buying something with your savings that turns out to be a financial albatross because you lose your job. You might simply get robbed. There is a reason why so many lottery winners and multi-millionaire athletes go bankrupt. Part of the reason is due to money mismanagement. Another part of it is that the more you have, the crazier you get, and the more you have to lose. Once you expect bad things to happen, you become mentally ready for anything. Here are some things to do if you receive a financial windfall.
* Feel blessed every day. If you are privileged to live in a developed country with a developed legal system, solid infrastructure, and a free society you have the ability to make more money if you so choose. Do not let pessimists with defeatist attitudes get you down. If scores of immigrants who don’t even speak English can strike it rich in America, why can’t those who are born in America and speak English fluently? If you do not believe in yourself, nobody else will believe in you. If you still think life is fair, take the next flight to Calcutta, India and tell me why your life is so tough again. I guarantee you will stop feeling sorry for yourself, stop over eating, and start believing that you can make things happen for the better.
* Someone will always have more than you. Don’t worry. As soon as you get that 50 foot boat, someone will berth next to you with a 75 foot boat. It is an inevitability that someone else will be smarter, better looking, richer, and seemingly happier than you. You’re either going to get jealous, or get inspired to figure out what allowed them to succeed. At least once a month, I go jogging around Pacific Heights, the most expensive area in San Francisco to gain some inspiration. I marvel at the mansions owned by Larry Ellison, Gap founder Don Fisher, and many more. The list goes on and on about people who created, took risk, and succeeded. I use their success as motivation to work harder every single day.
* It’s better to make less money than lose money. This is a conservative way of thinking which is often compared to “playing not to lose, rather than playing to win.” Those who are able to manage their money the most effectively are the ones who minimize their losses. If you lose 50% of your money, it takes a 100% return to get back to even. There were people who made fun of me for investing 35% of my wealth in 4.2% yielding CDs during the bull market. They weren’t making fun of me when some lost 60% to 100% of their net worths given they were 100% to over 100% tied to the markets due to margin. People talk about losing out on inflation all the time. That’s true, but you’d much rather have an erosion of buying power rather than a decline in principal.
* Your actions will make a difference. There are those who think hope is a strategy. Hopefully you are not one of them. Small actions over a consistently long period of time make a tremendous different in the amount of wealth you can create. Examples include: 1) raising your savings rate by 1% every month until you cry Uncle, 2) refinancing your mortgage every time rates are at least 0.5% lower to save tens of thousands of dollars in interest, 3) reading a new book on money management every six months and 4) not eating so much sugar so you don’t die early. Do not bury your head in the sand and think everything will be OK. Take action! I’m so thankful there are now free wealth management tools like Personal Capital that have allowed me to easily track my money and optimize my finances. It’s almost unfair the advantages we have today vs. folks from yesteryear. We’d be foolish not to take advantage of all the internet has to offer.
* Nobody cares more about your money than you. Get on your money like a gorilla on a banana because you care more than anybody about your finances. Not even your handsomely paid financial adviser cares as much because s/he is busy juggling multiple clients. Always have a little devil on your shoulder questioning whether you are making the right investment or spending properly before you do.
ACTIONS YOU CAN TAKE WITH YOUR LIQUID MONEY
Everybody should be saving at least 10% of their income a year, and preferably MUCH more. Once you start getting the ball rolling, it’s pretty easy to continue. The goal is to continue growing your savings while maximizing your returns. If you want to know whether you are on track, here’s a realistic post on how much savings you should have at various ages.
I suggest people diversify their liquidity for the following three reasons below:
1) You need to protect yourself from yourself. When all your cash is sitting in one account for you to easily withdraw, you have a greater tendency to spend your savings on things which are not necessary. I am a prodigious saver, so when I started seeing my money market account grow to over six figures, I started to waste money on things like cars and fancy watches. It was as if my savings was burning a massive hole in my pocket!
2) Each financial institution has different strengths and weaknesses. Some might have more readily accessible ATM machines. Others might have higher savings rates. While still others might provide better concierge service. Try as banks might, they can’t be all things to all people. It’s important to spread your money out, especially if you have more than $250,000 to maximize your returns.
3) The FDIC only guarantees your money up to $250,000 per individual. It’s not a good idea to put $1 million in savings or CDs all with one bank because you never know when economic Armageddon could result in another bank run.
THREE MAIN BANKING CATEGORIES TO CONSIDER
1) The Operationally Efficient Bank. The first bank account is for working capital needs, namely where your paycheck goes, and where you pay all your bills. This bank has the best tools for bill pay with the most branches for accessibility. Citibank is a good example of a ubiquitous bank with good online tools. Unfortunately, their savings rates are paltry, so I do not hold much in terms of savings here. Your operationally efficient bank is where you are constantly “Going Broke.” In other words, you run a tight ship of having just enough to pay all your bills, and have nothing else left over.
2) The Freedom Bank. The second bank is strictly for long term savings via money markets and CDs. This bank may not have as big of a footprint, but it doesn’t matter because you don’t need to access money from this bank. That’s what bank #1 is for. Due to lower overhead, Bank #2 provides better long term savings rates. My favorite online bank, EverBank is offering a 1.1% rate v.s 0.1% on average looks particularly good right now. I’ve got $50,000 deposited in EverBank as I wait for investing opportunities. Do not tempt yourself by creating a checking account with your Freedom Bank. You want money to easily come in (ever notice tellers don’t require IDs when depositing?), but very difficult to go out.
3) The Lockdown Bank. The third and final bank is for your debt, namely mortgages, personal loans, and car loans. By loading the majority of your debt with one bank, you compartmentalize your debt which may relieve you of any mental stress related to this debt. It’s easier to tackle your debt at one bank and employ the “Snowball Method.” Furthermore, from the bank’s point of view, you may get better rates given you are such a good debtor customer. You’re buying debt in bulk from Costco if you will, and in normal times, they want your business and will give you discounts. During crisis times, it’s also good to have all your debt in one place because your bank will do their best to work with you, especially if you live in a non-recourse state where they can’t go after your other assets if you default on your mortgage!
If you’ve got one bank that can do it all, then great! I don’t know one that exists, but at the very least, consider one bank for your operational transactions, and another bank to that provides the best rates for your savings and loans.
CALCULATE YOUR INCOME AND EXPENSES
You need a budget because you need to know where your money is going. Have you ever withdrawn a hundred bucks from the ATM machine only to peak into your wallet a days couples later and wonder where the hell most of your cash went? The same thing happens on a much grander scale with your finances if you do not create a budget.
* Create a budget. If you don’t have Excel, use a Google docs spreadsheet. If you don’t leverage free tools like Personal Capital to keep track of your money, then write everything out by hand! Make sure you list every single expense you incur per month, give it an extra 10% increase for cushion and then add up all your incomes. Chances are, the number of line item expenses way outnumber your income. On trick is to try and match the number of income line items with the number of expense line items. If you can get the ratio to two expense items for one income item, you are doing a great job!
* Stress test your budget. You’ve got to stress test your budget by creating a worst case scenario where all your income goes to zero and your expenses increase by 50%. Chances are this will not happen, but you’ve got to figure out how long you can survive if this happens. It’s all about calculating your expense coverage ratio. If your expense coverage ratio is less than 1 year, then you need to start cracking on contingency plans and developing alternative income streams.
* Do a little dreaming. On the flip side, you should create some X Factor line items in your income and asset category which could happen. No, winning the lottery should not be a positive X Factor. I’m talking about things such as: side business, inheritance, second jobs, company sale, private investments, and so forth. It’s always good to do a little dreaming if you do get a nice boost in income. Now pretend what are the first three things you would do if your dreams came true. Make sure your spending does not surpass your income boost. Otherwise, you’ll stay stuck in neutral.
ACTIONS YOU CAN TAKE WITH YOUR INVESTMENTS
Everybody’s risk tolerance is different, so it’s important to understand what you’re willing to handle. I only invest about 35% of my net worth in the stock market, because my pay and career were already levered to the fortunes of the stock market. Now that I’m an entrepreneur with little correlation to the stock market, I’m increasing my stock market allocation. Besides, I’m pretty sanguine about the market’s outlook.
* Ask yourself how much you are willing to lose. I wasn’t willing to lose more than 35% of my net worth in the stock market hence why I didn’t allocate more than 35% of my net worth in equities. At the same time, I wasn’t willing to lose more than 30% of my net worth in the real estate market either. Real estate can be a riskier animal in down times due to leverage. If everything went to hell, I knew I would at least have roughly 35% safe in FDIC insured CDs and savings accounts.
* Aggregate all your investments. If you have multiple accounts like me, but only pay attention to a few of them for whatever reason, you are not properly rebalancing your portfolios to adjust for risk. I have a 401K and an E*Trade portfolio. My 401K is more long-term, while my E*Trade portfolio is more speculative in nature. Both are important to my net worth, but I tend to view them separately. Furthermore, I have deferred company stock and a couple private equity investments ranging from alcohol to real estate. Without aggregating all my investments, I am only guessing at what the right exposure should be. This is why leveraging the internet makes a lot of sense. Before you can effectively manage your money, you’ve got to make sense of your money.
* Always continue learning about yourself. You will find that your attitudes towards risk change as you get older. Some people nearing retirement get so afraid of losing money they put everything into annuities and CDs (Related: CD Investment Alternatives). While other people might decide to take on more risk because they have more money. Children or a non-working spouse might also play a huge role in your risk tolerance. Whatever the case may be, find your own congruency and invest accordingly.
* Always continue learning about your investments. The reason why I recommend everybody rebalance at least twice a year is because it forces you to learn about your investments. Lots of things change throughout the year. There are quarterly earnings reports, political regime changes, and loads of economic data that come out that alter risk parameters. If you are a do-it-yourself type of investor, it’s up to you to stay on top of your investments. Listen in on the management calls, follow their social media presence online, set up a Google alerts about your biggest investments. There are a lot of landmines in this world to avoid!
* Keep your mind active in finding new ideas. How many of you actually spend at least 30 minutes a week thinking about new investment ideas? Do you put two and two together when every single woman you see on the street starts wearing Lululemon yoga outfits? Do you automatically think of shorting municipal bonds with Obama as President given he wants to raise taxes? There are money making ideas right now. You just have to spend some time looking, or associating yourself with someone who is looking!
BE THE MASTER OF YOUR WEALTH
One of the good problems of building wealth and following my advice is that you end up with a diverse amount of money accounts. You’ve got one of your rental property mortgages with one bank because they were running a special to boost their market share. You’ve got three CDs with another bank because they were providing higher than market rates to win more capital. Meanwhile, you’ve got an investment account open with another bank because of their diverse array of structured note products.
The internet has made it easier than ever to move capital to where you will make the highest return. It’s easier than ever to shop around for the lowest mortgage rates, car loans, and credit cards as well. Keep track of your money by opening up an account with Personal Capital where you see everything all in one platform. If there’s one message to take away from this post is that optimizing your finances is paramount to building long term wealth. Saving 1% or making 1% more a year adds up to big bucks.
Spend time actively managing your money. Leverage the Internet to love the process. After a while, it becomes a game to see where you can maximize and make the most. Eventually you’ll get to the point where money becomes less of a focus because you know in great detail how your money is working for you. At this point, you’ll have all the time in the world to spend more time on things most important in your life.
Photo: Waialae, Oahu, 2013.